1. Internal Control Principles
Chapter 1:
Introduction to Internal Control
Internal Control Principles

2. Internal Control Principles
Definition
Internal Controls are defined as the employment of all means within an organisation to promote, direct, govern and check upon its various activities for the purpose of seeing that its objectives are meet.
Internal Control Principles

3. The Importance of Internal Control
The objectives of an internal control system are to:
Ensure the integrity, relevance and reliability of information.
Safeguard the entity’s assets.
Detect and deter fraud and error.
Maintain efficient and effective use of resources.
Ensure compliance with both management policies and external regulations.
Internal Control Principles

4. Definition Internal control consists of the following components:
(a) the control activities (C);
(b) the entity’s risk assessment process (R);
(c) the information and communication
system (I);
(d) monitoring of control (M); and
(e) control environment (E).
This can be remembered using the mnemonic CRIME
Internal Control Principles

5. Internal Control Principles
Definition
Controls are the result of management’s:
Proper planning.
Organising.
Directing.
The term internal control distinguishes between:
A control within the organisation
and
An externally existing control, e.g. laws, regulations, etc.
Internal Control Principles

6. Achievement of Internal Control
Some of the means by which organisations achieve internal control are:
An organisational structure
Policies
Procedures
Personnel
An accounting system
Budgeting procedures
Reporting mechanisms
Internal reviews
Internal Control Principles

7. Key Aspects of Internal Control
The key aspects of a good internal control system are that all the policies, procedures, practices and methods that are carried out in the organisation to ensure the objectives are met, that assets are safeguarded and that transactions are accurately recorded. These controls will help to minimise fraud and error. Internal controls needed to be analysed and reviewed in line with changing systems
Internal Control Principles

8. Components of Internal Control
Control activities - Policies and procedures must be established and executed to help ensure the actions identified by management to address risk are effectively carried out.
Risk assessment - The entity must be aware of and deal with the risks it faces. Both internally and externally.
Information and Communications – This is the identification, retention and transfer of information in a timely manner enabling personnel to execute their tasks
Monitoring - The entire control process must be monitored, and modifications made as necessary.
Control Environment - The control environment is the foundation for all other components of internal controls and provides discipline and structure.
Internal Control Principles

9. Audit and Internal Controls
What is actually done in an Audit? Auditor – gains knowledge of the system, inspects, observes, talks to staff, inspects documents, looks at current controls, identify weaknesses Results in – Flowcharts, list of weaknesses, suggestions for improvements, advice to management, risk assessment This can be done for a whole system or subsystems, with in that system. Each system (or subsystem) involves three stages; Input, Processing, Output
Internal Control Principles

10. Audit and Internal Control
The auditor will:
Collect findings in a series of working papers
Carry out preliminary evaluation of controls to determine control risk
Carry out compliance tests on a sample, or perform observation tests and identifying physical assets
Internal Control Principles

11. Internal Control Principles
What is Control Risk?
Is the risk that a material fraud/error in a transaction/balance will find its way through the control system without being detected If the Internal Control (IC) structure is strong/ adhered to then the risk will be low. If the IC structure is weak/poor the risk is higher and systems design and development will need to be initiated
Internal Control Principles

12. Preliminary Evaluation of Internal Controls
The auditor, or systems consultant, studies and evaluates the system of internal control to establish which controls they can place reliance on and then decides on the nature, extent and timing of audit procedures to be used during the audit process.
Internal Control Principles

13. Preliminary Evaluation of Internal Controls
The auditors work has the following stages:
Review and documentation of controls
Preliminary evaluation of the system
Initial report to management on weaknesses and possible fraud/error
Initial estimates of control risk
Compliance tests
Revised estimates of control risk
Report to management on weaknesses found in the compliance stage
Internal Control Principles

14. Internal Control System Objectives
An Internal Control System has the following key objectives:
Completeness of transactions
Validity of records
Accuracy of records
Operational environment
Security and adequate safeguards
Accountability
This refers to the five primary recording objectives in an accounting system
Internal Control Principles

15. Internal Control Principles
Things to consider
When deciding which controls should be assessed need to consider the following:
Materiality
Size of the entity
Nature and ownership of the entity
The diversity and complexity of the operations
Legal and regulatory requirements
The nature and complexity of systems that are part of the entities internal controls, such as service organisations
Internal Control Principles

16. Internal Control Features
A good system of internal controls will include:
Segregation of duties
Authorisation
Custody
Recording all transactions
Reconciliation and checking
Extensive documentation
Complete audit trial
Documentation
Job Rotation
Internal Control Principles

17. Internal Control Features
Accounting records/procedure controls
Systems review and maintenance
Comparison – stock take, asset stock take
Internal Audits
Internal checks and verifications
Management review of reports
Management supervision
Personnel controls
Security of assets and records
Staff Training
Internal Control Principles

18. Design of Internal Controls
How effective an internal control system is will depend on how it has been designed and whether it meets some of the objectives and features of a good internal control system Evidence that a control procedure is likely to achieve its objectives includes evidence that the procedure is theoretically sound in its design. So on paper it looks good. This is consider a good starting point
Internal Control Principles

19. Corporate Governance and Internal Control
What is Corporate Governance?
A very simple definition that is easy to remember is: corporate governance is the system by which organisations are structured and controlled.
It is primarily concerned with accountability of management and directors to the shareholders and regulatory bodies.
Internal Control Principles

20. Internal Control Principles
Corporate Governance
Management is responsible for creating and maintaining control systems. Corporate governance is critical in the day-to-day running of the business. Risk Management is also important. Sound controls assist in minimising any types of risk. Procedures and Practices need to be documented, legislation needs to be complied with and reporting requirements enforced by the Corporations Law need to be adhered to also.
Internal Control Principles

21. Management Accountability
Directors are accountable to shareholders and the CEO is responsible to the board for the day-to-day management of the organisation. In Australia the ASX has published the Corporate Governance Principles and Recommendations which companies listed on the stock exchange are expected to adhere to. These require the board and management to take responsibility for the adequacy of internal controls
Internal Control Principles

22. Internal Control Principles
Business Risk
All businesses face risk. Risk includes:
Cash Flow Risk
Not being able to pay debts.
Risk of changes in tastes/technology
Consumers have changing tastes, products go in and out of fashion
Economic Risk
The risk of a change in the business cycle causing an economic downturn and a drop in sales.
Hazard Risk
These are risks that are not considered economic, such as disasters and terrorist attacks.
Internal Control Principles

23. Internal Control Principles
Business Risk
Interest Rate Risk
A rise in interest rates will make debt unsustainable.
Competition Risk
New competitors can undermine sales.
Internal Control Principles